Streetwise Professor

March 9, 2014

The Energy Weapon

Filed under: Economics,Energy,Politics,Russia — The Professor @ 12:03 pm

There’s a lot of talk about exploiting the US energy boom to undermine Putin and Russia.  This boom may have profound effects in the long run, but there is nothing that can be done now that can materially harm Putin in to punish him for his anschluss in Crimea, or subsequent aggressive moves he may make.

Yes, the US restrictions on exports of natural gas and crude oil are economically idiotic, even absent geopolitical considerations.  But even if those bans were eliminated tomorrow (a huge if, given he who sits in the White House-or golfs in Key Largo, as the case may be) Europe’s energy situation would not change one whit.

It would be possible to start moving large quantities of crude if the export ban were lifted, but this would be largely offset by a decline in US exports of refined products.  A major effect of the ban is to distort where crude is refined, not the total supply of crude and refined products (especially in the short run).  The major effect of the ban at present is to benefit US refiners who refine crude that is selling at below world prices because of the ban and export the products.  One study estimates that eliminating the ban would drop world oil prices by cents not dollars.

With respect to natural gas the situation is even less favorable.  Even if DOE granted all pending LNG export licenses, it will be years before product will start flowing.  Cheniere received the first license, in May, 2011, and its facility will not come on line until late-2015 at the earliest.  The company had a head start because it was converting an existing facility built to import LNG: other facilities will take longer to build because they are starting from scratch.

The long run impact of eliminating the export ban depends on the elasticity of supply of gas in the US.  If it is very elastic at current price levels, then yes, once the ban is lifted world prices will fall substantially, and Russia will be hit hard by that.  If supply is less elastic, the impact will be far smaller.  The elasticity of supply will depend crucially on technological factors, including the suitability of new formations to fracking and horizontal drilling, the depletion rates of wells, and the rate of technological innovation.  All of these factors are quite uncertain, and if the experience of the past decade says anything, it says be leery about making predictions about natural gas supply.

In brief: US energy export policy is stupid, but fixing the stupidity will have no appreciable impact on Russia for years.

Similarly, fixing stupid European policies on energy (e.g., fracking bans, massive renewables subsidies like Energiewende) should be done for reasons independent of geopolitics, and even if done tomorrow will have no material impact on European energy prices or Russian energy revenues for years to come.

The main way to impose substantial costs on Russia today via energy would be to impose trade sanctions.  Given the fact that the oil market is essentially global in scope, and that coordinating a global boycott of Russian oil would be virtually impossible, natural gas is a more feasible target.  Europe could boycott Russian gas  unilaterally, and there is no effective way for Russia to sell that gas to Asia or anywhere else.

There is a substantial asymmetry here.  Russia depends heavily on gas exports.  Approximately 25 percent of the Russian government’s revenue comes from Gazprom. The knock on effect on the Russian economy would likely be huge, as severe fiscal constraints would likely put substantial strains on the Russian banking system.

Yes, Europe would be hurt by higher prices and lower consumption of gas.  But gas comprises a far lower percentage of European expenditures than it does of Russian income, meaning that the hit on Europe would be far smaller.  Moreover, some of the impact could be mitigated by substantially increasing coal imports, increased Norwegian production, and some diversion of LNG from Asia to Europe, especially to the UK (which has excess LNG import capacity and could use LNG to displace North Sea gas which it could then pipe to Europe).   Moreover, winter is ending, and the cost of a supply interruption in the spring and summer would be far less than the cost in the winter.

But I doubt that is going to happen, because of another asymmetry.  The asymmetry in political will.  Old Europe has no stomach for a confrontation with Putin over Crimea, Ukraine, or much of anything else. (And yes, Donald Rumsfeld was an a$$hole-a claim I can vouch for based on family experience-but the Old Europe vs. New Europe formulation does capture an essential truth, especially where Russia is involved.) This lack of intestinal fortitude means that Old Europe-and especially Germany-is unwilling to pay any price to punish Putin.  Talk is free, and that’s all they are willing to pay.

And don’t think for a moment that Putin hasn’t based his plans on exactly that calculation.

In an attempt to scare off any attempt at sanctions, Russia has threatened retaliation: Lavrov has told Kerry any such moves will “boomerang.”  Other Russian officials have said that Russia can insulate itself from the west, thereby making it immune to any sanctions.

The retaliation that has been threatened includes expropriation of the assets of western companies.  A quite predictable Russian reaction, and typically self-destructive.  Any such expropriation would just cement Russia’s reputation as a lawless country where foreign investors rush in where angels fear to tread.  Russian equity valuations would crater, and direct investment would too.  Capital flight would accelerate.  The costs inflicted on Russia would dwarf those inflicted on the US and Europe, and would last for years.

Other that that, a great plan!  Another major asymmetry: any Russian retaliation would harm Russia far more than Europe or the US.  Some boomerang.

It reminds me of the old joke about the genie who grants the muzhik one wish, with one condition: anything the muzhik wishes for he gets, but his neighbor gets double. The muzhik thinks for a minute, then says: “I wish that you pluck out one of my eyes.”

All that said, I do not think that economic sanctions in the form of boycotting Russian energy or other exports, or cutting off imports (e.g., of drilling equipment) are the most effective, or the least costly, way of imposing costs on Putin and the elite on whom he depends. As I have said since Georgia, 2008, the best way to attack Putin and the elite is to go after their money in the west. (This policy is getting widespread publicity now.  I will lay claim to being a very early advocate.)

Such a measure is targeted on those who make the decisions, rather than Russia and Russians generally: as such, it could not be used by Putin to claim that the west was waging a war on Russia.  Indeed, it could undermine his political support not just among the elite who would be paying the price for his adventures, but among the broader population who are already disgusted by corruption and who would be unlikely to have any sympathy for that corruption being exposed, and the ill-gotten gains being seized.  The cost on western economies would very small indeed.  It would represent a victory for the rule of law.

But this would impose some costs on some very connected people in the west.  Moreover, precisely because it would strike so deeply at Putin it would cause him to lose his sh*t, and fear of that causes the Euros to shrink away from it in terror.

But this is something the US can pursue unilaterally.  Yes, given that most dirty Russian money is in Europe or the Caribbean, these measures would be much more effective if the Europeans participated. But the US still can wield considerable power (note how it forced Switzerland to heel on tax issues-not something that I agree with, btw, just pointing out that the US has leverage) and indeed, the mere threat of exposing what it uncovers could make the Europeans think twice.

But again, there is a lack of will.  Hope drives policy: “If we concede Crimea to Putin, he will stop.”

In sum, there is a powerful policy tool at our disposal.  A far better tool than is available in most such circumstances.  Other tools (sanctions) are more costly.  Yet other supposed tools-increasing US energy exports-are chimerical.

If we’re serious, we’ll use it.  But I have my doubts that we’re serious. If Europe (and to a lesser degree the US) has demonstrated anything in recent years, it is that they are past masters at kicking the can.  Crimea, Ukraine, and Putin are likely to be just another can.

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  1. It is going to cost Putler a lot to take over Crimea – it is a corrupt cesspool, and someone is going to have to pay for utilities and pensions (pensions were a very big deal in the sovok union, and still are in the post sovok arena), etc.

    In the meantime:

    Comment by elmer — March 9, 2014 @ 1:11 pm

  2. Elmer:

    he SNL skit is in very poor taste. But the cast are all Obama Kool-Aide drinkers anyway. And barely funny.


    Comment by VP — March 9, 2014 @ 8:24 pm

  3. That strategy has rapidly diminishing returns, if it has any potential left at all. On the day Yanukovich fled Kiev, the first thing that the mayor of Kharkov did was to get on a flight to Switzerland and then to Russia. Presumably he was preparing for a Crimean scenario in Kharkov, and just to be safe emptied his Swiss bank account and moved everything to Russia.

    Comment by aaa — March 9, 2014 @ 9:57 pm

  4. Pensions are a very big deal in the post-Soviet space because they are structured as a government-run defined-contribution program. So it’s a lot like when Detroit wanted to cut retirement benefits to municipal employees.

    Comment by aaa — March 9, 2014 @ 10:01 pm

  5. Professor,

    EU and the Resource Federation, joined at the hip they are. Edward Lucas warned us years ago!

    Comment by So? — March 10, 2014 @ 12:47 am

  6. @aaa

    In Detroit, the municipal employee retirement benefits and the salaries were extravagant.

    During sovok times, and in post-sovok times, the penseeyee were and are meager. And are quite often simply not paid. Due to massive corruption.

    not sure why we’re talking about Detroit – it’s not analogous.

    In the meantime, Vlad Dracul Putler warns Turkey that if Turkey defends the Crimean Tatars, then he will unleash the Kurds on the Turks.

    dezinformatsiya, provokatsiya i maskerovka

    Comment by elmer — March 10, 2014 @ 8:40 am

  7. And as Reagan did years before that, when the Europeans first started taking Soviet gas.

    The ProfessorComment by The Professor — March 10, 2014 @ 2:26 pm

  8. Professor, what you should do is start buying the excess US natural gas, liquefying it, exporting it to Ukraine and EU, and charging them $200 for the de-liquefied gas. This will undermine the Russian exports at $250 and make you a very rich man. Right?

    Comment by vladislav — March 11, 2014 @ 1:25 am

  9. > And as Reagan did years before that, when the Europeans first started taking Soviet gas.

    When Reagan did this, the USA was not a bankrupt country that owes $17 trillion to China, Russia, etc.

    Comment by vladislav — March 11, 2014 @ 1:27 am

  10. Since 1999 I have been saying: “It is a major crime to wage unprovoked wars and to steal other countries’ territories”. Why did it take the US until August 2008 (just 6 months after the US and its NATO collaborators officially recognized their theft of Kosovo from Serbia as final) to suddenly pay attention to this obvious principle?

    Comment by vladislav — March 11, 2014 @ 2:36 am

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